SGPS Financial Charges Deduction Under Article 32(2) EBF – IRC Arbitration 570/2015-T

ARBITRAL AWARD

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Prof. Doctor Fernando Borges Araújo and Prof.ª Doctor Ana Maria Rodrigues (arbitrators-members), appointed by the Deontological Board of the Administrative Arbitration Center to form the Arbitral Tribunal, constituted on 17-11-2015, agree on the following:

1. Report

A…, SGPS, S.A. (hereinafter briefly referred to as "Applicant" or "A…"), legal entity number…, registered in the Commercial Registry Office of Lisbon under the same number, with registered office at Avenue…, no.…, in Lisbon, filed a request for constitution of a collective arbitral tribunal, pursuant to article 2, no. 1, a) and 10, nos. 1 and 2, and 17-A of Decree-Law no. 10/2011, of 20 January (Legal Framework for Arbitration in Tax Matters, hereinafter referred to only as LFATM), in which the Tax and Customs Authority is summoned, with a view to declaring illegal and annulling the act of dismissal of the hierarchical appeal and the act of correction of the taxable matter of the Applicant relating to the fiscal year 2011 and the subsequent corporate income tax (CIT) assessment no. 2014… .

The request for constitution of the arbitral tribunal was accepted by the President of the CAAC and automatically notified to the Tax and Customs Authority on 18-09-2015.

Pursuant to the provisions of paragraph a) of no. 2 of article 6 and paragraph b) of no. 1 of article 11 of the LFATM, as amended by article 228 of Law no. 66-B/2012, of 31 December, the Deontological Board appointed as arbitrators of the collective arbitral tribunal the signatories, who communicated acceptance of the appointment within the applicable time period.

On 04-11-2015 the parties were duly notified of such appointment, and did not express any intention to refuse the appointment of the arbitrators, pursuant to article 11 no. 1 paragraphs a) and b) of the LFATM and articles 6 and 7 of the Deontological Code.

Thus, in accordance with the provisions of paragraph c) of no. 1 of article 11 of the LFATM, as amended by article 228 of Law no. 66-B/2012, of 31 December, the collective arbitral tribunal was constituted on 17-11-2015.

The Tax and Customs Authority responded, arguing that the request should be judged unfounded.

By order of 04-01-2016, it was decided to dispense with the meeting provided for in article 18 of the LFATM and that the proceedings proceed with pleadings.

The Parties submitted pleadings.

The arbitral tribunal was regularly constituted and is materially competent, in accordance with the provisions of articles 2, no. 1, paragraph a), and 30, no. 1, of Decree-Law no. 10/2011, of 20 January.

The parties are duly represented, have legal personality and capacity, are legitimate and are represented (articles 4 and 10, no. 2, of the same decree-law and article 1 of Ordinance no. 112-A/2011, of 22 March).

The proceedings do not suffer from any defects and no exceptions were raised.

Thus, there is no obstacle to the examination of the merits of the case.

1. Factual Matters

2.1. Proven Facts

Based on the elements in the file and the administrative file attached to the case, the following facts are considered proven:

a) The Applicant is a company managing shareholdings;

b) The Applicant is the parent company of group B…, subject to taxation under the special regime for taxation of groups of companies;

c) In the year 2011, group B… comprised the following companies:

A… SGPS (parent company) - TIN …

C… SGPS - TIN …

D… - TIN …

E... SGPS - TIN ...

F...- TIN ...

G..., S.A. - TIN...

H..., S.A. - TIN ...

I…- TIN …

J…, S.A. - TIN …

K…, S.A. - TIN…;

d) The Applicant monitored and advised on the management of its subsidiaries, having provided services to it in the year 2011 invoiced in the amount of € 2.784.168,00 (document no. 4 attached with the request for arbitral pronouncement, the contents of which are given as reproduced);

e) For the purposes of carrying out its activity, holding and managing shareholdings in commercial companies, A… uses:

(i) equity capital made available by its shareholders, remunerated through dividends and the potential for appreciation of A… (potential for realizable gains);

(ii) borrowed capital, remunerated in a manner (typically) disconnected from the potential appreciation of A… and the dividends earned by it;

f) A tax inspection was carried out on the Applicant, as parent company of the group, relating to the fiscal year 2011, for CIT purposes, in compliance with Service Order no. Ol2013… of 27-09-2013;

g) In that inspection a Tax Inspection Report was prepared which is contained in document no. 3 attached with the request for arbitral pronouncement, the contents of which are given as reproduced, which refers, among other things, to the following:

III - DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETIC CORRECTIONS TO THE TAXABLE MATTER

III.1. Corrections to the Group's taxable income

In the CIT income declaration form 22 which serves as the basis document for analysis in this inspection action, identified with number …-2013-… -05, the group declares a tax loss in the amount of € 15.401.734,93.

In accordance with article 70, no. 1 of the CIT Code, "the group's taxable profit is calculated by the parent company, through the algebraic sum of the taxable profits and tax losses determined in the periodic individual declarations of each of the companies belonging to the group". In this way, if there are changes to the tax results declared by the companies belonging to the group, the taxable profit thereof will have to be adjusted by the same amount.

Considering the corrections made to the taxable profit of the parent company, in the amount of € 5.989.205,47 (five million, nine hundred and eighty-nine thousand, two hundred and five euros and forty-seven cents), the group's tax loss totals € 9.412.529,46 as shown in the following table:

Values in euros

In view of the above, a correction will be made at the level of the group's tax result of the aforementioned amount, which results from:

III.1.1. From corrections made to the individual taxable profit of the company "A…, SGPS, S.A."

In compliance with Service Order no. Ol2013… of 2013-04-30, an external inspection procedure was carried out for the period of 2011, to the company A… SGPS, SA, (TIN:…).

The conclusions of the inspection action were communicated to the company in accordance with the grounds under no. 1 of article 77 of the General Tax Law and are contained in the tax inspection report prepared by the UGC on 2013-12-11, a copy of which is attached and which constitutes annex A, with 55 pages, which was communicated to the taxpayer in accordance with office no. … of 2013-12-17.

Following the aforementioned inspection action, corrections to the declared tax result were identified, made on individual terms to the company mentioned above which were fixed at the total amount of €5.989.205,47 (five million, nine hundred and eighty-nine thousand, two hundred and five euros and forty-seven cents), and concern:

Financial charges not deductible in light of the provisions of articles 32 of the TBF and 23 of the CIT Code:

The taxpayer increased the taxable profit by the amount of € 6.492.147,18 relating to financial charges incurred with the acquisition of equity interests, however in accordance with both no. 2 of article 32 of the Tax Benefits Statute and article 23 of the CIT Code, the value of such charges and € 12.481.352,65 do not contribute to the determination of Taxable Profit, so the amount of € 5.989.205,47 was corrected, corresponding to the difference between the value determined by the tax administration and the value determined by the taxpayer.

Thus, the individual taxable profit was corrected based on the grounds contained in points III - 1.1. and IX - 1), of the Inspection Report attached and forming an integral part of this Tax Inspection Report (pages 6 to 16 and 44 to 47 of the individual report - Annex A).

h) In the Tax Inspection Report relating to the individual inspection carried out on the Applicant in compliance with Ol2013… of 20-04-2013, the Tax Inspection Report was prepared which appears as annex A of the Tax Inspection Report of the inspection relating to the group, which appears in document no. 4 attached with the request for arbitral pronouncement, the contents of which are given as reproduced, mentions, among other things, the following:

III - DESCRIPTION OF FACTS AND GROUNDS FOR PURELY ARITHMETIC CORRECTIONS TO THE TAXABLE MATTER

From the audit of the selected accounting-tax areas, carried out in accordance with the procedures in use and with the depth considered appropriate to the circumstances, situations were detected that did not conform to the applicable tax legislation, which gave rise to the following corrections:

III.1. Corrections to taxable income - CIT

III.1.1. Non-deductible financial charges: € 5.989.205,47

(A) Description of the facts practiced by the inspected taxpayer

The taxpayer recognized as an expense for the period in its accounting, reflected in the account "69 - Financing expenses and losses", a total of interest borne in the amount of € 20.753.512,85.

In determining its respective taxable profit for the period, it increased the accounting result, under article 17 of the CIT Code, by the amount of €5.492.147,18 relating to financial charges associated with the acquisition of equity interests not deductible as expenses by application of the provisions of article 32 of the Tax Benefits Statute (TBF) - the taxpayer submitted calculation schedules, which are attached and constitute Annex no. 1 to this report.

From the combination of the above, it follows that the company considered as a fiscally eligible expense financial charges borne on loans obtained by the company in the amount of € 14.261.365,67 which, in light of the provisions of article 23, no. 1, of the CIT Code and as it is also applicable to it article 32 of the TBF as a result of A… being a Limited Partnership Company (SGPS), must be analyzed.

Verifying that the remunerated assets, namely bank deposits and subordinated loans, represent approximately 15% of remunerated liabilities, it follows from here the evidence that these are essentially intended to finance investments in equity interests and within these the supplementary contributions, which represent approximately 87% of the net asset.

(B) On the interpretation of the norm of article 32 of the TBF

The legal framework for SGPS, provided for in Decree-Law no. 495/88, of 30 December, defines that the purpose of such companies is "the management of shareholdings as an indirect form of exercising economic activity" (see no. 1 of article 1 of that normative).

No. 2 of the same article adds, as amended by article 1 of Decree-Law no. 318/94, of 24 December, that participation in a company is considered an indirect form of exercising economic activity thereof when it does not have an occasional character and reaches at least 10% of the capital with voting rights of the participating company, either alone or together with participations of other companies in which the SGPS is dominant.

Thus the legislation sought to limit the activity of SGPS to the management of stable shareholdings, avoiding them serving as a means of speculative financial activity or tax evasion regarding gains on capital.

Law no. 32-B/2002 of 30 December (State Budget Law for 2003) came in its article 38 to introduce a significant change to the tax regime applicable to the activity that constitutes the typical purpose of SGPS's through the alteration it inserted in article 31 (current article 32) of the TBF.

This tax regime is characterized by the non-taxation of income arising from the activity of managing shareholdings (dividends and gains/losses on the sale of shareholdings) as well as the non-acceptance as a tax expense of financial charges borne with financing obtained for the acquisition of equity interests.

This is implemented in no. 2 of article 32 of the TBF which establishes that "Capital gains and losses realized by SGPS, (...) from equity interests they hold, provided they are held for a period of not less than one year, and, as well, financial charges borne with their acquisition do not contribute to the formation of the taxable profit of these companies."

This regime is embodied in the granting of a benefit which, however, was compensated by the non-contribution, for the purposes of determining taxable profit, of financial charges borne, creating an environment of neutrality between gains on certain financial assets and expenses associated with the liability necessary for the acquisition and maintenance of those assets. Assets that in the future generate, as a whole, gains excluded from taxation.

Thus, article 32 establishes the existence of a link between the acquisition and holding of equity interests over a given minimum period and the tax relevance of financial charges borne with their acquisition.

The disregard as expenses of financial charges for the purposes of determining taxable profit, embodied in no. 2 of article 32 of the TBF, constitutes a corollary of the general principle of necessity of expenses according to which tax deduction is conditioned by its connection with obtaining income subject to tax and from which it follows that "if certain expenses are related to income not subject to tax they are not tax deductible", a principle established in the provisions of no. 1 of article 23 of the CIT Code.

From the analysis of the elements presented by the company to demonstrate the calculations of financial charges not accepted as expenses by article 32 TBF it is concluded that A… used a formula to determine the part of financial charges borne that relate to the acquisition of financial investments in subsidiaries, however, considering only as relevant for these calculations the cost of equity interests held, the acquisition value of the shares of the companies in which it participates.

That is, the company did not consider in its calculation formula the value recorded in accounting as financial investments that relates to supplementary contributions and accessory contributions.

In this respect and having regard to the ratio legis of article 32 of the TBF, it is important to demonstrate that the concept of equity interests for the purposes of this norm covers equity interests and supplementary contributions, as well as accessory contributions under the same regime.

It should be noted, however, that this equivalence to "equity interests" only covers supplementary contributions and accessory contributions under the regime of supplementary contributions that are demonstrably subject to a regime identical to that established in article 210 and et seq. of the Commercial Companies Code, from which we believe the following essential aspects should be highlighted:

1. not being remunerated;

2. their restitution cannot occur if it results that the company's net situation falls below the sum of capital and legal reserve;

3. their restitution depends on a resolution of the shareholders;

4. that they cannot be restituted after bankruptcy is declared of the company.

(C) From equity interests and accessory contributions subject to the regime of supplementary contributions

Given the particular interests of taxation, it becomes evident that the meaning and conceptual scope of the expression equity interests will be broader than that of mere participation in equity capital.

i. In light of the role played in the beneficiary company:

In fact, supplementary contributions perform throughout their useful life a function of support to permanent capital, similarly to equity capital, and consequently have, as a rule, a high permanence in the company, therefore, substantively, are covered by the concept of equity interests and subject to the regime of gains and losses on capital.

Supplementary contributions, a paradigmatic example of financing through equity capital, consist of contributions made by shareholders, to reinforce them, at a particular moment in the life of a company, taking the form of additional capital. Thus, and although supplementary contributions present distinctions compared to equity capital, they nevertheless have with this, in what concerns this matter, an analogous nature.

In this regard, João Antunes defends in "Supplementary contributions, accessory contributions and advances", Economic Life. "Supplementary capital contributions have a dual function: the capitalization of the company, that is, adapting its equity to social needs or it can also function as a guarantee to creditors, because they cannot be returned if Equity falls below the sum of capital and legal reserve, that is, it is a guarantee to creditors and that is one of the functions of Equity of a company."

This is also the understanding supported by Sofia Gouveia Pereira in "Supplementary contributions in Portuguese Corporate Law", page 245, Principia Publisher, January 2004 edition, where she states that "...as for legal nature we chose to consider supplementary contributions a premium (later), or "price increase on the share" bringing them close to equity capital and distancing them from shareholder loans, as for their function, this could be, as we have seen, either reinforcement of equity capital, acting as "unnamed" equity capital or "second line" (...).

In the same sense, Gonçalves da Silva and Estevas Pereira consider that supplementary contributions are justified for two concurrent reasons:

• Because it is not always possible to foresee what capital is necessary for the development of social business, at least in certain periods;

• Because, "although they do not constitute a capital increase, they are equivalent to it, dispensing with compliance with the respective legal formalities and the expenditure of inherent costs (...) adding further that "In reality, supplementary contributions constitute additional capital, distinct from nominal capital, occupying an intermediate place between this and properly so-called reserves, so they should be taken to a specific account of the additional net position, precisely with the following code and title: «53 - Supplementary Contributions» " (our emphasis).

ii. In light of accounting classification:

According to the provisions of no. 2 of article 11 of the GTL "Whenever, in tax norms, terms specific to other branches of law are used, they shall be interpreted in the same sense as they have there, unless another derives directly from the law."

As considered by Casalta Nabais, in "Tax Law", 5th Edition, Almedina Editions, p. 165, "given the important and close relations it maintains with the various domains of commercial law, it is understood that such a segment of tax law should have particular concerns for harmonization, which means, in particular, that the CIT Code and the Commercial Companies Code should duly consider the discipline contained in the CSC, POC, CVM, etc., just as these should not disregard the discipline contained in those codes".

In that sense, the express intention of the legislator should be emphasized when in the preamble to Decree-Law no. 159/2009 it states that «the maintenance of the model of partial dependence determines, from the outset, that, whenever own tax rules have not been established, the accounting treatment is adopted, as well as the terminology that derives from it».

The determination of taxable profit, and consequently of CIT to be assessed, is based on the accounting result, therefore it is natural that historically the concepts advocated at the level of accounting are considered in the framing of the term for tax purposes.

Thus, it is important to assess whether in light of accounting regulations supplementary contributions are considered equity interests.

From the perspective of the beneficiary, and in accordance with the Accounting Standardization System (SNC), supplementary contributions should be recorded by the beneficiary in account «53 - Other instruments of equity". The explanatory note states that "This account will be used to recognize supplementary contributions or any other financial instruments (or their components) that do not fit the definition of financial liability. In situations where financial instruments (or their components) are identified with financial liabilities, the appropriate rubric of accounts «25 - Financing obtained» or «26 - Shareholders/Partners» should be used".

From the perspective of the transferring entity, it was verified that already in the previous accounting framework, the Opinion of the Accounting Standardization Commission (CSC) no. 8/97, of 29 January 1997, states that supplementary contributions should be classified "in a specific subdivision of the appropriate sub-account of account «411 - Equity Interests» ", and such understanding is also applicable to accessory contributions that are subject to the same legal framework.

With the entry into force of the SNC, supplementary contributions granted continue to be included in account «41 – Financial Investments», similar to what occurred during the POC, taking into account their economic substance.

iii. In light of the coherence of the tax system:

Supplementary contributions, as well as accessory contributions under the regime of supplementary contributions, as financial investments included in non-current assets, follow, in their sale, the regime of gains and losses on capital contained in articles 46 et seq. of the CIT Code, so losses suffered with the transfer for consideration of accessory contributions under the regime of supplementary contributions represent tax-wise a loss on capital, subject to the corresponding regime.

In this sense, see Opinion no. 33/2010 of the CEF which, on the thema decidendi "Losses from the sale of supplementary contributions", follows the understanding sanctioned by His Excellency the Secretary of State for Tax Affairs through his Dispatch no. 536/2004-XVI, of 15 December 2004 and reiterates that «accessory contributions under the regime of supplementary contributions, "as financial investments included in fixed assets, follow, in their sale, the regime of gains and losses on capital contained in articles 43 et seq. of the CIT Code [current articles 46 et seq.], given that losses suffered with the transfer for consideration of accessory contributions under the regime of supplementary contributions represent tax-wise a loss on capital, subject to the corresponding regime (see article 43 of the CIT Code), which includes the necessity of cost required by article 23, no. 1, of the CIT Code" (...) and that "To losses associated with the sale of accessory contributions under the regime of supplementary contributions the regime that the CIT Code grants to equity interests in article 42, no. 3 [current article 45, no. 3], as well as in article 23, no. 7"» is applied, concluding that «these accessory contributions [subject to the legal regime of supplementary contributions] should, equally, be considered for all purposes, namely those provided for in article 23, nos. 5 to 7, (current article 23, nos. 3 to 5) of the CIT Code, as being part of the concept of "equity interests».

On the other hand, it is important to highlight the reasons why, in substance, financial charges borne with financing of accessory contributions should be excluded for the purposes of determining taxable profit, under article 32 of the TBF, embodying the principle contained in article 23 of the CIT Code.

(...)

As for the method to consider for the disregard as expense of financial charges related to the acquisition of equity interests, in order to identify the sources of capital applied in these acquisitions and, in particular, borrowed capital related to such acquisitions, it must be considered that one of the characteristics of money is fungibility, which prevents the possibility of determining the specific application of capital obtained through a particular loan.

Thus, the most appropriate solution is to impute the remunerated liabilities of SGPS, first to the remunerated loans granted by them to subsidiary companies and other investments generating interest, affecting the remainder to the remaining assets, namely equity interests, proportionally to their respective acquisition cost.

In that sense, the Tax Administration, interpreting and applying the law, made known Circular no. 7/2004, of 30 March of DSIRC11 where the following understanding is sanctioned:

Temporal scope of application: "it is applicable to financial charges borne in tax periods beginning after 1 January 2003, even if they relate to financing contracted before that date", as indeed follows from no. 5 of article 38 of Law 32-B/2002, of 30 December, which establishes that the (new) regime provided for in article 31 of the TBF (current article 32) is applicable "to gains and losses realized in periods beginning after 1 January 2003".

Tax period in which financial charges corrections should be made: "Regarding the tax period in which financial charges should be disregarded as costs for tax purposes, the tax correction of those borne with the acquisition of participations that are likely to benefit from the special regime established in no. 2 of article 32 of the TBF should be carried out, regardless of whether all conditions for the application of the special regime for taxation of gains are already met. If it is concluded, at the moment of sale of the participations, that all requirements for application of that regime are not met, the financial charges that were not considered as cost in previous periods will be considered as a cost in that period".

Method to be used for the purposes of allocating financial charges: (...) given the extreme difficulty in using, in this matter, a method of direct or specific allocation and the possibility of manipulation that it would allow, such imputation should be carried out based on a formula that takes into account the following: remunerated liabilities of SGPS and SCR should be imputed, first, to remunerated loans granted by them to subsidiary companies and to other investments generating interest, affecting the remainder to the remaining assets, namely equity interests, proportionally to their respective acquisition cost.

(...)

Nothing in the letter of no. 2 of article 32 of the TBF prevents the application of the indirect method in the aforementioned allocation of financial charges, given the characteristic of fungibility of money, with the consequent impossibility of determining the specific application of capital obtained.

Thus, in order to implement the provisions of no. 2 of article 32 of the TBF and in accordance with the methodology embodied in Circular no. 7/2004; financial charges borne with liabilities intended to finance equity capital interests, supplementary contributions and accessory contributions with the regime of supplementary contributions are excluded for the purposes of determining taxable profit, since the expression equity interests encompasses, in the terms demonstrated, these realities.

It should be emphasized that the taxpayer used in determining the non-deductible financial charges for tax purposes the methodology advocated by Circular no. 7/2004 having adopted the determination of non-deductible financial charges on a monthly basis – see Annex no. 1 - methodology also followed by the Tax Administration in its calculations as it is considered to be the one that best reflects the reality that the norm aims to tax given the financial information produced by the company.

That is, the divergence existing between the calculations considered by A… and those proposed by the Tax and Customs Authority results from the company's non-consideration of the part of financial investments corresponding to supplementary contributions as being part of the concept of «equity interests» subject to the limitations of article 32 of the TBF, which as has already been demonstrated does not respect the ratio legis of that norm.

Thus, from the calculation made to determine the financial charges to exclude, for the purposes of determining taxable profit, considering that supplementary contributions and similar, and here are included those designated "Share Premium", are covered by the concept of equity interests, a total of non-deductible financial charges was determined in the amount of € 12.481.352,65 - see Annex no. 2.

It being demonstrated that the non-compliance of the taxpayer's action with the applicable legal framework exists, it is proposed, in view of the value of financial charges from financing directed to the acquisition of equity interests, including the allocation of supplementary contributions and "share Premium", determined by the tax inspection and the value already increased to the taxable profit (ORM22/Q07/C752) by the taxpayer, the correction by the difference that is embodied in the amount of € 5.989.205,47 -- see referenced Annex no. 2.

(F) From the norm of article 23 of the CIT Code

Although, by way of working hypothesis, supplementary contributions were not applicable the special regime provided for in article 32 of TBF, then always would have to be assessed their deductibility in light of article 23 of the CIT Code.

Financial charges borne by an entity – whether or not an SGPS – with obtaining funds which are intended to be granted without remuneration by that same entity to a subsidiary are not considered tax expenses given the norm of no. 1 of article 23.

This article establishes the general principle regarding the tax deductibility of expenses borne by entities subject to this tax.

(...)

It is thus considered that the deduction of interest and other charges should follow the same rules that are generally applicable to other expenses borne by companies, being therefore their deductibility conditioned on compliance with the basic principle according to which they will be tax deductible only when they are demonstrably indispensable for the realization of income or gains subject to tax or for the maintenance of the source generating the respective taxpayer's income.

In fact, the capital obtained, generating financial charges, when channeled to the granting of supplementary contributions to the subsidiaries are manifestly not used in the activity of the company bearing the charges, for which no taxable income reverting compensates the expenses, insofar as supplementary contributions are not remunerated.

(...)

It is thus understood that, even if supplementary contributions were not considered equity interests for the purposes of applying article 32 of the TBF, financial charges borne with financing obtained for the granting/maintenance of unremunerated supplementary contributions are not accepted as an expense under article 23 of the CIT Code, following vast jurisprudence, both of the SAC and the ACT.

In summary, even if "Share Premium" or supplementary contributions as the company refers is not integrated in the concept of equity interests, financial charges borne with financing used for the granting of supplementary contributions/"share premium" to subsidiaries are not considered tax deductible, under article 23 of the CIT Code, because those capital are not associated with remunerated assets.

i) Following the inspection relating to group B…, the Tax and Customs Authority issued CIT assessment no. 2014…, of 07-04-2014, the contents of which are given as reproduced, relating to the fiscal year 2011, in which it applied the correction referred to in the Tax Inspection Report;

j) The Applicant filed a gracious objection to the assessment, which was not decided;

k) The Applicant filed a hierarchical appeal of the implied dismissal of the gracious objection, which came to be dismissed by dispatch of 30-04-2015, of the Sub-Director General of the Tax and Customs Authority (document no. 1 attached with the request for arbitral pronouncement, the contents of which are given as reproduced), in which the following was concluded:

In view of the above, financial charges borne both with the acquisition of equity interests and with the granting of supplementary contributions are excluded for the purposes of determining taxable profit, given what is established in article 32 of the TBF.

In this context, it is our understanding that the correction made by the tax inspection services is in accordance with what is established in no. 2 of article 32 of the TBF, given that the value of financial charges of 12.481.352,65€ does not contribute to the formation of taxable profit for the fiscal year 2011, in accordance with the calculations made in the inspection report.

Taking into account that the Appellant increased taxable profit by the amount of 6.492.147,18 € relating to financial charges borne with the acquisition of equity interests, the amount of 5.989.205,47 € was corrected, corresponding to the difference between the value determined by the Tax Administration and the value determined by the Appellant.

l) Borrowed capital used by the Applicant is remunerated through the fixing of interest paid periodically;

m) On 01-09-2015, the Applicant filed the request for constitution of the arbitral tribunal which gave rise to the present proceedings.

2.2. Unproven Facts

There are no facts with relevance for the examination of the merits of the case that have not been proven.

2.3. Justification of the establishment of the factual matters

The proven facts are based on the Tax Inspection Report and the documents attached with the request for arbitral pronouncement, with no controversy about them.

1. Matters of Law

The Tax and Customs Authority made corrections to the taxable matter of the fiscal year 2011 of group B…, of which the Applicant is the parent company, by understanding that the following should not be considered as expenses: financial charges borne by those companies for the realization of supplementary contributions and similar ("Share Premium"), to subsidiary companies.

The correction made has a dual basis.

In the first place, the Tax and Customs Authority understands that the limitation contained in no. 2 of article 32 of the Tax Benefits Statute (TBF), as amended in 2011, applies to this situation, because supplementary contributions fall within the concept of «equity interests».

Furthermore, the Tax and Customs Authority understood, in summary, that the aforementioned financial charges do not meet the requirements to be considered as expenses, required by article 23 of the CIT Code, as amended in 2011, because they were incurred in favor of other legal and economically independent entities.

Being autonomous grounds, each with the potential to support the corrections made, they will be examined separately, without prejudice to the fact that, if it is concluded that one of them provides legal support for the decision taken, knowledge of the other will be foreclosed as useless.

3.1. Question of the qualification of supplementary contributions as «equity interests» for the purposes of article 32, no. 2, of the TBF, as amended in 2011

Article 32, no. 2, of the TBF established, as amended in 2011, the following:

2 - Capital gains and losses realized by SGPS, SCR and ICR from equity interests they hold, provided they are held for a period of not less than one year, and, as well, financial charges borne with their acquisition do not contribute to the formation of the taxable profit of these companies.

From the final part of this norm it results that financial charges borne with the acquisition of equity interests do not contribute to the formation of the taxable profit of SGPS.

In the case at hand, the financial charges in question were borne by the Applicant to carry out supplementary contributions and similar ("Share Premium"), to its subsidiaries, so the applicability of this norm to the situation depends on the qualification of these contributions as «equity interests».

«In determining the meaning of tax norms and in qualifying the facts to which they apply, the general rules and principles of interpretation and application of laws are observed» (article 11, no. 1, of the GTL), which constitutes a referral to article 9 of the Civil Code.

In no. 2 of the same article 11 it is established that «whenever, in tax norms, terms specific to other branches of law are used, they shall be interpreted in the same sense as they have there, unless another derives directly from the law».

From this norm it results that, although the rule is that the terms used in tax norms should be interpreted with the same scope they have in other branches of law, there is an exception, which directly derives from tax law that the meaning of the term used in tax law is different from what it has in other branches of law.

In fact, it is an exception that is in line with another general interpretive rule, which is that special law takes precedence over general law in its specific field of application. That is, if it directly derives from a tax norm, special for the situation it regulates, the meaning of a given term, it will not be interesting to know whether that meaning corresponds or not to what is used in general law, because that meaning directly resulting from the law for a specific situation will necessarily be the one that must be adopted and not the meaning used in any norm that does not have the nature of special law for the said situation.

In any case, from no. 2 of article 11 of the GTL it results that, in good hermeneutics, the first task of the interpreter of tax law to ascertain the scope of a term used in it is to determine whether the meaning of that term directly derives from tax law.

Only if one is not faced with a situation of this type, can appeal be made to the meaning of terms used in other branches of law.

Now, in the case at hand, for clarification of the question of whether supplementary contributions are covered by the concept of «equity interests» there is a norm from which it directly results that they are not included in this concept, which is no. 3 of article 45 of the CIT Code, in the wording of Decree-Law no. 159/2009, of 13 July, in force in the year 2011.

It is established in this no. 3 of article 45 the following:

3 – The negative difference between capital gains and losses realized through the transfer for consideration of equity interests, including their redemption and amortization with capital reduction, as well as other losses or negative variations in assets relating to equity interests or other components of equity, namely supplementary contributions, contribute to the formation of taxable profit in only half their value.

Two concepts are used in this norm: that of «equity interests» and that of «other components of equity».

«Equity interests» are also «components of equity», as can be inferred from the word «other», but the scope of «equity interests» is necessarily more restricted than that of «equity», which will include, in addition to «equity interests» also «the other components».

As the norm is worded, supplementary contributions will be encompassed in the concept of «other components of equity» and not in «equity interests», as the reference to them appears after this latter concept and not after the first.

In truth, if it were understood, for this purpose, that supplementary contributions were integrated in the concept of «equity interests», it is obvious that the reference to them would be included after this concept and not after the concept of «equity»: that is, it would say « (...) losses or negative variations in assets relating to equity interests, namely supplementary contributions, or other components of equity, contribute to the formation of taxable profit in only half their value».

That reference to supplementary contributions did not exist in the wording of article 42 of the CIT Code ([1]) of Law no. 32-B/2002, of 30 December ([2]), only being made in the wording introduced by Law no. 60-A/2005, of 30 December, so the legislative change was made with the aim of clarifying the tax scope of the concepts used, namely the concept of «equity interests», showing that it, in the perspective of the legislator of the CIT Code, did not cover supplementary contributions.

Being a change with a clarifying scope, it is to be presumed with reinforcement that the legislator knew how to concretize in adequate terms this objective (article 9, no. 3, of the Civil Code), and if it intended to make explicit that supplementary contributions, for the purposes of CIT, fall within «other components of equity» and not in «equity interests».

This delimitation of the concept of «equity interests» which is extracted from the said no. 2 of article 45 is made for the purposes of determining losses, which is included in the matter dealt with by article 32, no. 2, of the TBF (it is a norm that sets aside in relation to SGPS the tax relevance in general provided for in the CIT Code for gains and losses) so, having to presume that the legislator expressed its thinking in adequate terms (under article 9, no. 3, of the Civil Code), justifies the conclusion that the same concept of «equity interests» was used in the special norm as was used in the norm that provides for the general tax relevance.

Furthermore, the norm of article 32, no. 2, of the TBF was reformulated by Law no. 64-B/2011, of 30 December, already after the amendment introduced by Law no. 60-A/2005 in article 45 of the CIT Code and the new wording of that norm maintains the reference only to «equity interests» without any allusion to «other components of equity» to which article 45, no. 2 alludes.

This conclusion, extracted from the literal text of article 32, no. 2, of the TBF, combined with article 45, no. 2, is confirmed by the reason for the special regime of gains and losses realized by SGPS, which does not apply to supplementary contributions, as proficiently explained in the award of the CAAC rendered in case no. 12/2013-T, in these terms:

"in general, the regime of capital gains aims to grant a favorable special regime to tangible and financial assets (shares and quotas) of companies, as a way to combat the lock-in effect – a phenomenon in the tax system of realization that conditions the rational economic flow of assets (buying and selling) for reasons relating to fiscal constraints (payment of tax). In essence, to avoid the scenario of a subject who does not sell an asset (share or quota) of which he is the holder – and all economic reasons would advise him – only because at that moment he will pay a high tax (because taxation is only discharged with the sale of the asset and not in the cadence of its annual appreciation). It is this reason that justifies the under-taxation of tangible and financial assets (shares and quotas), embodied in a special tax regime for taxation of capital gains.

And none of that occurs with supplementary contributions. They are returned, at par, according to the rules of commercial law. There is not, nor is an attempt being made to force, the existence of a (secondary) market with large volumes of transactions in supplementary contributions. And it is not credible that the few holders of supplementary contributions below par do not want to receive their nominal value, for fear or concern about the payment of tax associated; or that this is such an economic obstacle as to justify creating or inserting them in the special regime of gains and losses."

Thus, it is concluded that article 32, no. 2, of the TBF, as amended in 2011, when establishing, referring to «equity interests», that «do not contribute to the formation of taxable profit» of SGPS the «financial charges borne with their acquisition», does not rule out the relevance to the formation of taxable profit of financial charges borne with supplementary contributions.

Therefore, the corrections made do not have legal support in article 32, no. 2, of the TBF.

3.2. Question of the indispensability of financial charges borne with supplementary contributions to subsidiaries for the formation of taxable profit of the Applicant

The non-consideration by the Tax and Customs Authority, for the formation of taxable profit of the Applicant, of the aforementioned financial charges with supplementary contributions to subsidiaries was also based on the understanding that these expenses cannot be considered indispensable for such formation.

This matter was already examined, with the same factual and legal assumptions, in CAAC case no. 39/2013-T and 734/2014-T, with whose decision one agrees, so its grounds will be followed.

3.2.1. The interpretation of the concept of necessity of costs or losses

The interpretation of the concept of necessity contained in article 23 of the CIT Code has, in Portuguese tax law doctrine, in TOMÁS TAVARES and ANTÓNIO PORTUGAL, authors of fundamental works regarding the elucidation of such concept.

For the first of these authors: "The legal notion of necessity is thus outlined, from the perspective of economic-business, by fulfillment, direct or indirect, of the ultimate motivation for obtaining profit. Necessary costs are equivalent to expenses incurred in the interest of the company or, in other words, in all acts abstractly subsumed in a lucrative profile."

And he continues: "(…) Necessity is subsumed in any and every act carried out in the interest of the company…The legal notion of necessity thus represses acts that are out of step with the scope of society, not inserting into the social interest, above all because they do not aim at profit".

The second author, regarding the question of which is the best interpretation of the concept of necessity, expresses the following position:

"The solution adopted among us (at least in doctrine), following the understandings advocated by Italian doctrine, has been to interpret necessity according to the corporate purpose. This position is present from the outset in the writings of Vítor Faveiro, who leads the necessity of the expense to its appraisal as an act of management in relation to the concrete corporate purpose, refusing that this necessity can be assessed freely from any subjective judgment of the law applier".

These works thus maintain that any economic loss (expense) that has a relationship with the corporate purpose, whether incurred in the context of the activity, or evidences a business purpose, will meet the requirement of necessity.

On the plane of jurisprudence, and especially as regards the deductibility of expenses relating to interest borne by companies that apply borrowed capital in financing subsidiaries, the Award of the SAC of 7 February 2007, rendered in case no. 1046/05, deserves to be highlighted, in which it is stated:

"From this it results that the costs provided for there cannot but respect, first and foremost, the contributing company itself.

That is, in order for a certain amount to be considered a cost of that company it is necessary that the respective activity be carried out by it itself, not by other companies.

Unless it were this way, how could the exercise of the activity of one company be imputed to another with which it had some relationship.

The disputed amounts correspond to interest on bank loans and stamp duty contracted by the appellant and applied in the gratuitous financing of an associated company.

Such amounts are therefore not directly related to any activity of the taxpayer inscribed in its corporate purpose, which is real estate ventures and management and not the management of shareholdings or financing of venture companies, nor do they even relate, even indirectly, to its activity.

Also here the notion of activity or of social interest is revealed as the striking feature in the tax admissibility of expenses, when assessed by article 23 of the CIT Code. And in the jurisprudence cited by the Applicant and the Tax and Customs Authority the predominant issue is, as would be expected, the question of the connection of the tax admissibility of financial expenses in relation to whether it is considered that the financing entity carries out or not, in those operations, its own activity.

Now, in view of what was mentioned, it is clear that, both on the doctrinal level and in the jurisprudential sphere, the connection to the activity will be the nuclear element of the interpretive key of the concept of necessity. Thus, and for the case at hand, the analysis of what is meant by "activity" of companies, in particular of an SGPS, is revealed to be essential.

Let us then see, on a general level, what we understand by activity of corporate entities; and then, in the case at hand, what should be understood by own activity of an SGPS.

3.2.2. The activity of companies

The activity of a corporate entity consists of the operations resulting from the use and management of its resources. Such resources are, in the first place, the assets that appear in the respective assets.

From the notion of "asset" that the accounting standard establishes, it can be concluded that both will be activity the management of a tangible fixed asset, as of an intangible one, as of a financial asset, or any provision of service.

Thus, suppose that company ALFA participates in company BETA in the proportion of 100%. The first is therefore the holder of a financial asset. What "activity" results in the sphere of ALFA from the participation that it holds in BETA?

The first can intervene in the second, controlling its financial and operational policies so as to obtain benefits from it, determining the production of new goods or services, the minimization of expenses, or other measures that increase its future economic benefits.

But it is also clear that ALFA could intervene in BETA on the level of financial operations. Either by increasing BETA's capital in order to increase its investment capacity, or by providing it with financial means that strengthen BETA's treasury in order to increase its investment capacity, or by providing it with financial means that strengthen its treasury.

The entity ALFA, in the exercise of its own activity, administers and makes decisions concerning a financial asset, which results from said participation. This constitutes activity of ALFA and not of BETA. The latter benefits from this activity, suffers the effects of ALFA's decisions, but does not develop the activity of managing the participation.

If the managers of ALFA execute operations that affect the financing of BETA they are not developing the activity of third parties. They are developing ALFA's own activity, derived directly from the management of the financial asset translated into the participation in BETA. The company BETA has the nature of a participating entity, which gives to the decisions of the participant the qualification of its own activity, inherent to its purpose: the management of such participation. And such management may involve financing operations that are part of the activity of the participant.

The participated company is not just any entity foreign to the activity and interests of the participant. There is no expense in the sphere of the latter that has nothing to do with its corporate interest. The expense on interest incurred with capital obtained and subsequently provided to the subsidiary is made in the interest of the participant, as a direct consequence of its activity of managing an asset that emerges from a participation, which is real or potentially productive of income.

3.2.3. The activity of SGPS and the deductibility of financial charges in question

In accordance with the provisions of article 1 of Decree-Law no. 495/88, of 30 December ([3]) the companies managing shareholdings (SGPS) have as their sole contractual purpose the management of shareholdings in other companies, as an indirect form of exercising economic activities, a participation in a company being considered an indirect form of exercising economic activity thereof when it does not have an occasional character and reaches at least 10% of the capital with voting rights of the participated company, either alone or through participations of other companies in which the SGPS is dominant. ([4])

A participation in a company is considered an indirect form of exercising the economic activity thereof when it does not have an occasional character and reaches at least 10% of the capital with voting rights of the participated company, either alone or together with participations of other companies in which the SGPS is dominant.

In view of the above, it is clear that the activity of SGPS – a concept essential to assess the necessity of expenses incurred by them within the framework of the application of article 23 of the CIT Code – not only includes the management of shareholdings, but is this its sole contractual purpose.

Now, the management of shareholdings will naturally involve its acquisition, the operations of administration carried out by the participant necessary for the valuation of the acquired financial asset, the financing of such asset and the eventual later sale. All of this can be subsumed in the activity of an SGPS.

Thus, the financing of a subsidiary results from the interest of the participant, in order to, by guaranteeing the financial support of the acquired asset, increase its potential as a source of producing income.

In such a case, financial charges resulting from financing contracted for, subsequently, to strengthen the equity of a subsidiary are included, are part of the scope of the activity of an SGPS. This leaves no doubt given the provisions of the aforementioned norm, which regulates its activity. ([5])

It is thus concluded that, since these charges are related to the own activity of the SGPS, they meet the requirements on which the interpretation of the concept of necessity of article 23 of the CIT Code is based, namely in the part of no. 1 of this article in which importance is given to expenses necessary for the maintenance of the source producing income, which include expenses of a financial nature, expressly mentioned in paragraph c) of the same number.

By the foregoing, the second basis for the correction made by the Tax and Customs Authority to the taxable profit of the Applicant, relating to financial charges with the aforementioned supplementary contributions, also fails.

Thus, it is concluded that the corrections made do not have legal basis, so they suffer from a defect of breach of law due to error as to the legal assumptions, which justifies the annulment of the acts of CIT assessment and compensatory interest, as well as the respective statement of account settlement that were based on those corrections (article 135 of the Code of Procedure in Administrative Courts of 1991).

The dispatch of the Sub-Director General of the Tax and Customs Authority which dismissed the hierarchical appeal and maintained the contested assessment with identical grounds suffers from the same defect, so its annulment is also justified.

Thus, as the request for arbitral pronouncement should proceed, knowledge of the remaining questions raised is foreclosed, as being useless.

1. Decision

Accordingly, the members of this Arbitral Tribunal agree to:

– judge the request for arbitral pronouncement as well-founded;

– annul CIT assessment no. 2014…;

– annul the dispatch of the Sub-Director General of the Tax and Customs Authority of 30-04-2015, which dismissed the hierarchical appeal filed by the Applicant aimed at the annulment of such assessment;

1. Value of the Case

In accordance with the provisions of article 306, no. 2, of the Code of Civil Procedure and article 97-A, no. 1, paragraph a), of the Code of Procedure in Tax Matters and article 3, no. 2, of the Regulations on Costs in Tax Arbitration Proceedings, the value of the case is fixed at € 1.257.733,15.

1. Costs

Pursuant to article 22, no. 4, of the LFATM, the amount of costs is fixed at € 17.136,00, in accordance with Table I attached to the Regulations on Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Lisbon, 08-02-2016

The Arbitrators

(Jorge Lopes de Sousa)

(Fernando Borges Araújo)

(Ana Maria Rodrigues)

([1]) Article 42 of the CIT Code, in the renumbering performed by Decree-Law no. 198/2001, of 3 July, corresponds to article 45, in the renumbering of Decree-Law no. 159/2009, of 13 July.

([2]) The previous wording of the corresponding norm, introduced by Law no. 32-B/2002, of 30 December, was as follows:

3 – The negative difference between capital gains and losses realized through the transfer for consideration of equity interests, including their redemption and amortization with capital reduction, contributes to the formation of taxable profit in only half their value.

([3]) Wording of Decree-Law no. 318/94, of 24 December.

([4]) However, although the sole contractual purpose of SGPS is the management of shareholdings in other companies, article 4, no. 1, of the same decree-law, as amended by Decree-Law no. 318/94, of 24 December, permits SGPS to provide technical services of administration and management to all or some of the companies in which they hold participations.

([5]) As already mentioned, the grounds of the award rendered in CAAC case no. 39/2013-T were adopted in points 3.2.1., 3.2.2. and 3.2.3.